Steels rally after Morgan upgrade

Brokerage notes improving inventory, pricing trends

By

LeslieWines

NEW YORK (MarketWatch) - Prominent steel shares closed sharply higher Tuesday, after Morgan Stanley upgraded the sector to in-line from cautious, citing improving inventory, production and pricing trends throughout the industry.

Mittal Steel
MT, -0.12%
gained 2% to close at at $29.80 and U.S. Steel
X, +0.93%
gained 3% to $44.01.

"Due to industry discipline, we believe excess steel inventory has been worked off, production is likely to rise in the mid to late fourth quarter, steel prices appear to have bottomed and will begin to rise again early to mid-fourth quarter," said Morgan Stanley metals analyst Wayne Atwell, citing industry data.

The massive steel sector consolidation seen in recent years has resulted in a more disciplined steel industry that was able to reduce production faster during a recent pullback than in prior cycles, according to Atwell.

He estimated that the industrywide operating rate fell from 93% in January 2005 to 79% in August, enabling the steel industry to work off excess inventories

He also linked the improved prospects for the industry to rising prices for scrap and lengthening order books.

Based on comments from industry consultants and executives, Atwell said it appears that hot-rolled steel prices are now bottoming in the $390 to $420 a ton range, and should move up to $430 per ton in the fourth quarter. After the fourth quarter, the analyst expects the price to strengthen to as much as $470 per ton.

Domestic prices are benefiting from recent reluctance on the part of steel consumers to import metals during the recent soft phase, Atwell said.

Separately, Credit Suisse First Boston strategist Andrew Garthwaite raised his recommended weighting of the mining sector to 5% overweight from benchmark, citing valuation, but voiced concerns about the steel group.

Garthwaite noted that China is increasing its steel capacity more rapidly than other nations are, creating a potential threat for the U.S. industry. "... and by and large this increase in capacity is taking place with a near zero real cost os capital," he said.

On Monday some steel stocks were pressured by news that Japan will impose 15% tariffs on some U.S. products. However, the losses were limited by the fact that Japan is not a major importer of U.S. steel.

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